Updated: Jun 2, 2021
Thinking that Renting is an Automatic Waste of Money
Many will tell you “Buy a house! It costs the same as rent!” However, renting is often less expensive on a month to month basis. How is that you may ask? It’s because when you rent, the maintenance of the home is not on you. Renting is fine if you use it as a tool to save up money until you’re in position to buy a house the right way. Renting also makes more sense if you move very frequently-say every 3 years or less.
Do not let other people rush you into buying a house. Most people are broke.
Being in debt when you buy a home
Debt harms you cash flow. Before you buy a home, pay off all debt so that you have the maximum amount of money left over for emergencies or to invest.
Not Having an Emergency Fund
The unexpected will happen. It’s part of life. It is not unheard of for people to be out of work for months after being laid off. Before you jump into a home, you need to have 6 months of expenses put away for emergencies so you are better prepared to weather the storm of a loss in income. Note, this 6 month emergency fund needs to be based on your future mortgage payment, home insurance premium, and property tax cost. You can find a calculator here.
Small down payments
Paying little money down may seem like a sweet deal because it makes it easier to get into a home. However, a small down payment means you will pay more in interest over the course of the loan. You will also pay something called Private Mortgage Insurance or PMI. PMI is an insurance premium the bank charges you to insure themselves against you defaulting on the loan(Since you have so little money up front). It’s reasonable to estimate that it costs .5 percent of the loan amount per year. On a $245,000 home with a 3.5 percent down payment, this would amount to $99 per month. The bank will charge you this premium every month until you have 20 percent equity in your home.
You need to aim for 10 percent down on a home at least. Twenty percent is ideal as you avoid PMI altogether. A larger down payment also reduces the likelihood you will ever be upside down in your home-owing more on the house than it is worth.
Buying a house that is too expensive
Just because you get approved for a certain amount on a mortgage loan does not mean you can actually afford a house for that amount. The bank may know your income and your credit score, but they do not have the full picture of your financial life. A mortgage payment that is too high will rob you of cash flow that may be needed for investment in your retirement or saving up to replace an aging car.
Aim to pay no more than 25 percent of your household income toward your mortgage. This will prevent you from being house poor.
Getting more than a 15 year Mortgage
The thirty year mortgage is very common, but it is costly as far as interest is concerned. Say for instance you have a 245,000 dollar house. If you put 20 percent down, your payment will be $1,141.60 not counting insurance and property taxes. You will pay $165,974.38 in interest over the course of the loan assuming a 3.8 percent interest rate.
A shorter loan term brings with it a lower interest rate so let’s assume an interest rate of 3.2 percent on the 15 year mortgage. Your payment will be $1,715.59 and you will pay $63,806.37 in interest over the course of the loan. That is a whopping $102,168.01 saved on interest.
Even if you have a 30 year mortgage already, look for ways to attack it like a 15 year mortgage. The quicker you get out of debt, the less costly the loan will be.
For more advice on how to prepare for home-ownership, don’t hesitate to contact me.